[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

A critical report commissioned by the G20 group of the world's biggest economies has warned oil prices could be vulnerable to a LIBOR-style rigging scandal. The G20 study conducted by the Madrid-based International Organisation of Securities Commissions (IOSCO) has found that the current system of oil price reporting is "susceptible to manipulation or distortion". The report for global finance ministers states that:

1. Bank traders;
2. Oil companies; and
3. Hedge funds

have an “incentive” to distort the market and are likely to try to report false oil and gasoline prices to boost their trading profits. IOSCO is an association of organisations that regulate the world’s securities and futures markets. The super regulator warns that traders have opportunities to influence oil prices for their own profit.

Self-certification benchmarks and indices are likely to be manipulated?

Contamination Risk, Collusion and Further Alarm Bells

1. Both the LIBOR inter-bank lending rate at the heart of a global rate-rigging scandal and spot oil and gasoline prices are based on a system of trust. They are, effectively, unregulated. Tens of trillions of dollars of securities, derivatives and contracts are based on the oil and gasoline prices.

2. Physical oil traders and traders at various banks voluntarily report the prices they pay for oil contracts to Price Reporting Agencies (PRAs) like Platts, Argus and others. Each PRA uses a number of trades to decide what the benchmark price, quoted to the outside world, should be. IOSCO states that "this creates opportunity for a trader to submit a partial picture, ie, an incomplete set of its trades in order to influence the assessment to the trader's advantage."

3. The Global Financial Markets Association (GFMA) -- which represents large financial organisations -- is also critical of the perceived independence of Platts and its competitors: Argus, OPIS and ICIS-LOR, which also compile oil and gasoline prices for the market. Simon Lewis, chief executive of GFMA, has raised concerns about the “opaque” way the oil price is worked out. In an open letter to IOSCO he suggests price reporting agencies may not be as impartial as they claim, because they take fees from banks and oil companies to provide information intelligence. Specifically, he writes: "There is potential for conflicts of interest to arise where PRAs engage in revenue generation, price reporting and news services on oil markets, as incentives may arise to favour those who pay greater subscriber fees or provide greater access to market information." Mr Lewis calls for "barriers or fire walls to minimise contamination risk of information."

4. Journalists working at Platts and Argus are trained to check any figures which appear suspicious or spurious. However, they do not have the powers to challenge or investigate banks or individuals responsible for the oil and gasoline price submissions. Therefore, the journalists are not like regulators.

5. IOSCO also criticised a lack of transparency about the way banks compile their submissions. Platts says the data is based on "bids and offers that are tested in the marketplace." However, IOSCO raises the issue that there are insufficient safeguards to prevent collusion between two or more traders or banks as is currently suspected in the LIBOR scandal.

6. US regulators have pointed out the LIBOR rate-rigging scandal could spread to the oil market. Scott O’Malia, a senior official at the Chicago-based Commodity Futures Trading Commission (CFTC), has drawn attention to the “striking similarity” between the potential for manipulating oil and LIBOR.

7. UK regulators carrying out the Wheatley Review into the LIBOR manipulation have this week signalled they will look into whether other markets are also skewed and may include oil.

8. In the wake of the LIBOR scandal, banks are calling for reform of the oil price system, amid fears that it is open to abuse by a minority of physical oil traders. However, this may be special pleading.

9. Paul Tucker, deputy governor of the Bank of England, told the UK Parliament's Treasury Select Committee that Barclays’ abuse of the LIBOR system may be only one part of the banks’ dishonesty over crucial financial information.

10. Raymond Learsy, author of "Oil and Finance" and former commodities trader has been warning for many years that the oil market is open to corruption. “Given how important LIBOR is, if that can be manipulated, then why can’t oil be manipulated?” he said. “The price lends itself to manipulation. The oil price is not a true reflection of supply and demand.”

Pressure Mounts

Governments across the G20 nations are likely to come under pressure from fuel campaigners and politicians to expand their inquiries associated with the LIBOR scandal to investigate further whether oil prices have also been manipulated upwards. For example, politicians in the UK have called on the Bank of England and the British government to take heed of IOSCO’S finding about the oil market to prevent another crisis of confidence in the banking system.

Car Drivers Paying Over the Odds?

Have car drivers also been paying over the odds for gasoline or petrol as oil traders are likely to have tried to manipulate prices in the same way as interest rates? The wholesale price of oil is linked to the price at the pump by "benchmarks" which retailers use to decide how much to pay for future supplies. Almost all the petrol retailers buy their products based on Platts and Argus prices. If IOSCO thinks the price is open to manipulation it could well be and that would affect prices on the forecourts. The "benchmark" rate is calculated by data companies based on submissions from firms which trade oil on a daily basis – such as banks, hedge funds and energy companies. However, like LIBOR the market is not regulated. Instead it relies on the honesty of the firms to submit accurate data.

Price Reporting Agencies and Mechanisms

The price reporting agencies -- Platts and Argus -- have hit back at claims their prices are open to distortion. In a joint statement, Platts and Argus said there are “fundamental differences” in the way LIBOR and oil prices are reported. They argue they employ journalists to weed out false data submitted by oil traders. IOSCO says reporters are “well-aware that traders have an incentive to push the market one way or another and do not generally believe everything they are told”. However it points out this system is heavily reliant on the “experience and training” of journalists to make a judgement about what the oil price should be. Are journalists the best arbiters of the price of oil?

Conclusion

The controversy relating to how reflective quoted oil prices are of all physical trades has existed for many years. This has been of most concern in relation to thinly traded crude oil and this has led the major players in the oil industry to switch the marker crudes that they use from time to time. Whilst the IOSCO report for the G20 appears to be focussing on micro and short term manipulation of the wholesale market for oil, the possibility of a macro manipulation on a much bigger scale on a medium to long term time horizon is not being adequately addressed. The investigations are likely to reveal that the phenomenon of manipulating the price of oil is not new and goes back several decades. Self-certification -- whether it is in regard to LIBOR or the benchmark price of oil -- may be found to contain multiple incentives to profit from the exploitation of financial markets. This unfair competitive advantage -- typically for an oligopoly of major players -- can be easily eliminated using modern, transparent, transaction-based computerised reporting. When are the global financial market benchmarks and indices going to be automatically calculated in real time with 21st century technology?

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